-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LRw15bi9YwCyp+hmqGNCKKE0mKIJmpH1KqO2Gf+6cMvtk+7Y9QRBV6gX3g/dWYAj S7+yre433iinm2GWVpOAZQ== 0000895419-02-000002.txt : 20020414 0000895419-02-000002.hdr.sgml : 20020414 ACCESSION NUMBER: 0000895419-02-000002 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20011223 FILED AS OF DATE: 20020205 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CREE INC CENTRAL INDEX KEY: 0000895419 STANDARD INDUSTRIAL CLASSIFICATION: SEMICONDUCTORS & RELATED DEVICES [3674] IRS NUMBER: 561572719 STATE OF INCORPORATION: NC FISCAL YEAR END: 0627 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-21154 FILM NUMBER: 02527168 BUSINESS ADDRESS: STREET 1: 4600 SILICON DR CITY: DURHAM STATE: NC ZIP: 27703 BUSINESS PHONE: 9193135300 MAIL ADDRESS: STREET 1: 4600 SILICON DR CITY: DURHAM STATE: NC ZIP: 27703-8475 FORMER COMPANY: FORMER CONFORMED NAME: CREE RESEARCH INC /NC/ DATE OF NAME CHANGE: 19940224 10-Q 1 f10q_2002q2.txt QUARTERLY REPORT ON FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 23, 2001 Commission file number: 0-21154 CREE, INC. (Exact name of registrant as specified in its charter) North Carolina 56-1572719 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 4600 Silicon Drive Durham, North Carolina 27703 (Address of principal executive offices) (Zip Code) (919) 313-5300 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No The number of shares outstanding of the registrant's common stock, par value $0.00125 per share, as of January 31, 2002 was 72,611,340. CREE, INC. FORM 10-Q For the Quarter Ended December 23, 2001 INDEX Page No. PART I. FINANCIAL INFORMATION -------- Item 1. Financial Statements Consolidated Balance Sheets at December 23, 2001 (unaudited) and June 24, 2001 3 Consolidated Statements of Operations for the three and six months ended December 23, 2001 and December 24, 2000 (unaudited) 4 Consolidated Statements of Cash Flow for the six months ended December 23, 2001 and December 24, 2000 (unaudited) 5 Notes to Consolidated Financial Statements (unaudited) 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 Item 3. Quantitative and Qualitative Disclosures About Market Risk 22 PART II. OTHER INFORMATION Item 1. Legal Proceedings 22 Item 4. Submission of Matters to a Vote of Security Holders 23 Item 6. Exhibits and Reports on Form 8-K 24 SIGNATURES 25 -2- PART I - FINANCIAL INFORMATION Item 1 - Financial Statements CREE, INC. CONSOLIDATED BALANCE SHEETS (In thousands, except per share data) December 23, June 24, 2001 2001 ------------ ---------- ASSETS (Unaudited) Current assets: Cash and cash equivalents $144,337 $164,562 Short-term investments held to maturity 10,000 36,965 Marketable securities 13,917 6,675 Accounts receivable, net 34,740 34,850 Interest receivable 421 1,270 Inventories 18,244 15,202 Deferred income tax 12,825 4,172 Prepaid expenses and other current assets 1,535 2,220 ------------ ---------- Total current assets 236,019 265,916 Property and equipment, net 214,413 226,920 Goodwill and intangible assets, net 78,743 83,282 Long-term investments held to maturity 27,971 7,971 Patents, net 3,638 3,246 Other assets 23,338 27,788 ------------ ---------- Total assets $584,122 $615,123 ============ ========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable, trade $ 6,902 $ 14,148 Accrued salaries and wages 4,738 2,435 Other accrued expenses 2,437 5,156 ------------ --------- Total current liabilities 14,077 21,739 Long term liabilities: Deferred income taxes 3,850 3,850 Other long term liabilities 38 438 ------------ --------- Total long term liabilities 3,888 4,288 Shareholders' equity: Preferred stock, par value $0.01; -- -- 3,000 shares authorized at December 23, 2001 and June 24, 2001; none issued and outstanding Common stock, par value $0.00125; 90 91 120,000 shares authorized; 72,591 and 72,907 shares issued and outstanding at December 23, 2001 and June 24, 2001, respectively Additional paid-in-capital 511,130 518,781 Deferred compensation expense (955) (1,211) Retained earnings 65,085 76,001 Accumulated other comprehensive loss, (9,193) (4,565) net of tax ------------ ---------- Total shareholders' equity 566,157 589,097 ------------ ---------- Total liabilities and shareholders' equity $584,122 $615,123 ============ ========== The accompanying notes are an integral part of the consolidated financial statements. -3- CREE, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited)
--------------------------- --------------------------- Three Months Ended Six Months Ended --------------------------- --------------------------- December 23, December 24, December 23, December 24, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ Revenue: Product revenue, net $ 36,873 $ 37,587 $ 75,451 $ 71,898 Contract revenue, net 4,219 3,907 8,807 7,238 ------------ ------------ ------------ ------------ Total revenue 41,092 41,494 84,258 79,136 Cost of revenue: Product revenue 18,508 16,163 38,420 30,652 Contract revenue 3,209 3,257 6,559 5,844 ------------ ------------ ------------ ------------ Total cost of revenue 21,717 19,420 44,979 36,496 ------------ ------------ ------------ ------------ Gross profit 19,375 22,074 39,279 42,640 Operating expenses: Research and development 6,748 2,295 10,853 4,396 Sales, general and administrative 5,582 3,010 11,314 6,967 Other expense 18,820 62 19,670 62 Goodwill and intangible asset amortization 2,256 -- 4,511 -- ------------ ------------ ------------ ------------ (Loss) income from operations (14,031) 16,707 (7,069) 31,215 Other non operating (loss) (11,794) (11) (11,794) (99) Interest income, net 1,353 4,322 3,490 9,105 ------------ ------------ ------------ ------------ (Loss) income before income taxes (24,472) 21,018 (15,373) 40,221 Income tax (benefit) expense (7,096) 7,157 (4,458) 13,706 ------------ ------------ ------------ ------------ Net (loss) income $ (17,376) $ 13,861 $(10,915) $ 26,515 ============ ============ ============ ============ (Loss) earnings per share: Basic ($0.24) $0.19 ($0.15) $0.37 ============ ============ ============ ============ Diluted ($0.24) $0.18 $(0.15) $0.35 ============ ============ ============ ============ Shares used in per share calculation: Basic 72,457 71,495 72,705 71,154 ============ ============ ============ ============ Diluted 72,457 75,200 72,705 75,230 ============ ============ ============ ============
The accompanying notes are an integral part of the consolidated financial statements. -4- CREE, INC. CONSOLIDATED STATEMENTS OF CASH FLOW (In thousands) (Unaudited) Six Months Ended --------------------------- December 23, December 24, Operating activities: 2001 2000 ------------ ------------ Net (loss) income $ (10,915) $ 26,515 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation of property and equipment 15,337 9,050 Loss on disposal of property, equipment, and other impairment charge 18,935 62 Amortization of patent rights 124 87 Goodwill and intangible asset amortization 4,511 -- Amortization of deferred compensation 256 279 Deferred income taxes (8,453) 13,161 (Gain) on available for sale securities (558) (1,182) Tax benefits associated with stock option exercises 1,690 -- Other than temporary decline in value of long term investments 12,352 -- Changes in operating assets and liabilities: Accounts and interest receivable 959 (10,802) Inventories (3,015) (4,015) Prepaid expenses and other current assets 686 (287) Accounts payable, trade (7,246) 3,915 Accrued expenses and other long-term (817) (243) liabilities ------------ ------------ Net cash provided by operating activities 23,846 36,540 ------------ ------------ Investing activities: Purchase of available for sale securities (15,305) (7,176) Proceeds from sale of available for sale securities 2,103 5,837 Purchase of property and equipment (21,765) (57,388) Purchase of securities held to maturity (40,000) (56,606) Proceeds from maturities of securities held to maturity 46,965 50,640 Increase in other long-term assets (7,901) (21,670) Capitalized patent costs (516) (381) ------------ ------------ Net cash used in investing activities (36,419) (86,744) ------------ ------------ Financing activities: Acquisition fees for purchase accounting transaction -- (674) Repurchase of common stock (10,608) -- Net proceeds from issuance of common stock 2,956 6,531 ------------ ------------ Net cash (used in) provided by financing activities (7,652) 5,857 ------------ ------------ Net decrease in cash and cash equivalents $ (20,225) $ (44,347) Cash and cash equivalents: Beginning of period $ 164,562 $ 103,843 =========== ============ End of period $ 144,337 $ 59,496 =========== ============ Supplemental disclosure of cash flow information: Cash paid for income taxes $ 1,901 $ 414 =========== ============ The accompanying notes are an integral part of the consolidated financial statements. -5- CREE, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Basis of Presentation - --------------------- The consolidated balance sheet as of December 23, 2001, the consolidated statements of income for the three and six months ended December 23, 2001 and December 24, 2000, and the consolidated statements of cash flow for the six months ended December 23, 2001 and December 24, 2000 have been prepared by the Company and have not been audited. In the opinion of management, all normal and recurring adjustments necessary to present fairly the financial position, results of operations and cash flow at December 23, 2001, and for all periods presented, have been made. The balance sheet at June 24, 2001 has been derived from the audited financial statements as of that date. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted. It is suggested that these condensed financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company's fiscal 2001 Annual Report on Form 10-K. The results of operations for the period ended December 23, 2001 are not necessarily indicative of the operating results that may be attained for the entire fiscal year. Accounting Policies - ------------------- Principles of Consolidation The consolidated financial statements include the accounts of Cree, Inc., and its wholly-owned subsidiaries, Cree Lighting Company ("Cree Lighting"), UltraRF, Inc. ("UltraRF"), Cree Research FSC, Inc., Cree Funding LLC, Cree Employee Services Corporation, CI Holdings, Limited, Cree Technologies, Inc. and Cree Asia-Pacific, Inc. All material intercompany accounts and transactions have been eliminated in consolidation. Business Combination On December 29, 2000, the Company completed the acquisition of the UltraRF division of Spectrian Corporation, or Spectrian, through the purchase of assets of the business by Cree's wholly owned subsidiary, UltraRF, Inc. in a business combination accounted for under the purchase method. Under the terms of the Asset Purchase Agreement, UltraRF acquired substantially all of the net assets of the business from Spectrian in exchange for a total of 2,656,917 shares of Cree common stock valued at $113.5 million. Of the total shares issued, 191,094 shares were placed in escrow and proceeds from the sale of such shares retained in escrow to secure Spectrian's representations, warranties and covenants under the Asset Purchase Agreement. Under the terms of the escrow arrangement, one-half of the funds were released to Spectrian in June 2001 and the balance was released in December 2001 because no claims were made against the escrowed assets. -6- The consolidated financial statements reflect the allocation of the purchase price based upon fair value of the assets acquired, including goodwill of $81.5 million and other intangible assets of $6.3 million. Goodwill is being amortized on a straight-line basis over ten years and other related intangibles are being amortized over five to eight years. The results of operations of UltraRF have been included in the consolidated results of the Company since the date of acquisition. Business Segments The Company operates in two business segments, Cree and UltraRF. The Cree segment incorporates its proprietary technology to produce compound semiconductors using silicon carbide and gallium nitride technology. Products from this segment are used in automotive and liquid crystal display backlighting, indicator lamps, full color light emitting diode displays and other lighting applications as well as microwave and power applications. The UltraRF segment designs, manufactures and markets silicon-based LDMOS and bipolar radio frequency power semiconductors utilized in building power amplifiers for wireless infrastructure applications. Summarized financial information concerning the reportable segments as of and for the three and six months ended December 23, 2001 is shown in the following table. The "Other" column represents amounts excluded from specific segments such as interest income. In addition, the "Other" column also includes corporate assets such as cash and cash equivalents, short-term investments held to maturity, marketable securities, interest receivable and long-term investments held to maturity which have not been allocated to a specific segment. As of and for the three months ended December 23, 2001 (in thousands) Cree UltraRF Other Total - -------------------------- ---------- ---------- ---------- --------- Revenue $ 33,311 $ 7,781 $ -- $ 41,092 (Loss) income before income taxes (24,066) (1,759) 1,353 (24,472) Assets $ 288,815 $ 98,661 $ 196,646 $ 584,122 As of and for the six months ended December 23, 2001 (in thousands) Cree UltraRF Other Total - -------------------------- ---------- ---------- ---------- --------- Revenue $ 66,804 $ 17,454 $ -- $ 84,258 (Loss) income before income taxes (17,509) (1,354) 3,490 (15,373) Assets $ 288,815 $ 98,661 $ 196,646 $ 584,122 Comparable data for the three and six months ended December 24, 2000 is not presented because the company operated in one segment during those periods. -7- Reclassifications Certain fiscal 2001 amounts in the accompanying consolidated financial statements have been reclassified to conform to the fiscal 2002 presentation. These reclassifications had no effect on previously reported net income or shareholder's equity. Fiscal Year The Company's fiscal year is a 52 or 53 week period ending on the last Sunday in the month of June. The Company's 2002 fiscal year extends from June 25, 2001 through June 30, 2002 and is a 53-week fiscal year. The Company's 2001 fiscal year extended from June 26, 2000 through June 24, 2001 and was a 52-week fiscal year. Estimates The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual amounts could differ from those estimates. Revenue Recognition The Company recognizes product revenue at the time of shipment when title is transferred to the customer in accordance with the terms of the relevant contract. Revenue from government contracts is recorded on the percentage-of-completion method as expenses per contract are incurred. Contract revenue represents reimbursement by various U.S. Government entities to aid in the development of the Company's technology. The applicable contracts generally provide that the Company may elect to retain ownership of inventions made in performing the work, subject to a non-exclusive license retained by the government to practice the inventions for government purposes. Contract revenue includes funding of direct research and development costs and a portion of the Company's general and administrative expenses and other operating expenses for contracts under which funding is expected to exceed direct costs over the life of the contract. The specific reimbursement provisions of the contracts, including the portion of the Company's general and administrative expenses and other operating expenses that are reimbursed, vary by contract. Such reimbursements are recorded as contract revenue. For contracts under which the Company anticipates that direct costs will exceed amounts to be funded over the life of the contract (i.e., certain cost share arrangements), the Company reports direct costs as research and development expenses with related reimbursements recorded as an offset to those expenses. Cash and Cash Equivalents Cash and cash equivalents consist of unrestricted cash accounts and highly liquid investments with an original maturity of three months or less when purchased. -8- Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents, short-term and long-term investments, available for sale securities, accounts and interest receivable, accounts payable, accrued expenses and other liabilities approximate fair values at December 23, 2001 and June 24, 2001. Investments Investments are accounted for in accordance with Statement of Financial Accounting Standards No. 115, (SFAS 115) "Accounting for Certain Investments in Debt and Equity Securities". This statement requires certain securities to be classified into three categories: (a) Securities Held-to-Maturity -- Debt securities that the entity has the positive intent and ability to hold to maturity are reported at amortized cost. (b) Trading Securities -- Debt and equity securities that are bought and held principally for the purpose of selling in the near term are reported at fair value, with unrealized gains and losses included in earnings. (c) Securities Available-for-Sale -- Debt and equity securities not classified as either securities held-to-maturity or trading securities are reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity. At December 23, 2001, the Company held short-term investments in the common stock of publicly traded equity securities. The Company considers these investments to be strategic in nature; therefore, these investments are accounted for as "available for sale" marketable securities under SFAS 115. Therefore, unrealized gains or losses are excluded from earnings and are recorded in other comprehensive income or loss, net of tax. At December 23, 2001, the fair market value of these investments was $13.9 million with gross unrealized losses totaling $12.9 million. As of December 23, 2001, the Company's short-term investments held to maturity included $10.0 million in government bonds. The company purchased the investments with a portion of the proceeds from its public stock offering in January 2000. The Company has the intent and ability to hold these securities until maturity; therefore, they are accounted for as "securities held-to maturity" under SFAS 115. The securities are reported on the consolidated balance sheets at amortized cost, as a short-term investment with unpaid interest included in interest receivable. As of December 23, 2001, the Company's long-term investments consisted of $28.0 million in high-grade commercial paper, medium term notes and other debt securities that mature in June 2003 and August 2003. The Company has the intent and ability to hold these securities until maturity; therefore, they are accounted for as "securities held-to-maturity" under SFAS 115. These securities are reported on the consolidated balance sheet at amortized cost, as long-term investments with unpaid interest included in interest receivable if interest is due in less than 12 months, and as a long term receivable if interest is due in more that 12 months. -9- As of December 23, 2001, the Company maintained $23.3 million of net investments in the equity of privately-held companies, which are included in other assets on the consolidated balance sheet. Since the Company does not have the ability to exercise significant influence over the operations of these companies, these investment balances are carried at cost and accounted for using the cost method of accounting for investments. Management conducts a quarterly impairment review of each investment in the portfolio, including historical and projected financial performance, expected cash needs and recent funding events. Other-than-temporary impairments for investments are estimated and recognized if the market value of the investment is below its cost basis for an extended period or the issuer has experienced significant financial declines or difficulties in raising capital to continue operations. During the quarter ending December 23, 2001, the Company recorded an impairment charge on these investments of $12.4 million, representing the Company's best estimate of an "other than temporary" decline in value. This impairment charge was included as `other non-operating loss' on the consolidated statements of operations. Impairment of Property and Equipment In accordance with Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of ("SFAS 121"), the Company reviews long-lived assets for impairment based on changes in circumstances that indicate their carrying amounts may not be recoverable. During the quarter ended December 23, 2001, the Company recorded an impairment charge for property and equipment totaling $18.1 million related to assets to be disposed of, which is included in `other operating expense' on the consolidated statements of operations. This impairment charge was due to technology decisions or changes resulting in the obsolescence of the assets. These assets are being carried at the lower of their carrying amount or fair value less cost to sell. The majority of these assets will be destroyed due to the proprietary nature of the assets. Disposal of the impaired assets is expected to occur in the second half of fiscal 2002. Inventories Inventories are stated at the lower of cost or market, with cost determined under the first-in, first-out (FIFO) method. Inventories consist of the following: December 23, June 24, 2001 2001 ------------ ---------- (in thousands) Raw materials $ 3,867 $ 4,538 Work-in-progress 8,190 6,206 Finished goods 7,315 5,251 Reserve (1,128) (793) ============ ========== Total inventory, net $18,244 $15,202 ============ ========== -10- Research and Development Accounting Policy The U.S. Government provides funding through research contracts for several of the Company's current research and development efforts. The contract funding may be based on either a cost-plus, a cost-share or a firm fixed price arrangement. The amount of funding under each contract is determined based on cost estimates that include direct costs, plus an allocation for research and development, general and administrative and the cost of capital expenses. Cost-plus funding is determined based on actual costs plus a set percentage margin. For the cost-share contracts, the actual costs are divided between the U.S. government and the Company based on the terms of the contract. The government's cost share is then paid to the Company. Activities performed under these arrangements include research regarding silicon carbide and gallium nitride materials. The contracts typically require the submission of a written report that documents the results of such research. The revenue and expense classification for contract activities is based on the nature of the contract. For contracts where the Company anticipates that funding will exceed direct costs over the life of the contract, funding is reported as contract revenue and all direct costs are reported as costs of contract revenue. For contracts under which the Company anticipates that direct costs will exceed amounts to be funded over the life of the contract, costs are reported as research and development expenses and related funding as an offset of those expenses. The following table details information about contracts for which direct expenses exceed funding by period as included in research and development expenses: Three Months Ended Six Months Ended December 23, December 24, December 23, December 24, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ (In thousands) Net R&D costs $ 47 $ 174 $ 60 $ 239 Government funding 18 314 229 660 ------------ ------------ ------------ ------------ Total direct costs $ 65 $ 488 $ 289 $ 899 incurred ============ ============ ============ ============ Significant Sales Contracts On September 21, 2001, the Company entered into a new Purchase Agreement with Osram Opto Semiconductors GmbH & Co. ("Osram"), pursuant to which Osram agreed to purchase and the Company is obligated to ship certain quantities of LED chips and silicon carbide wafers through September 2002. The Purchase Agreement calls for certain quantities of LED chips to be delivered each month unless shipment is deferred by Osram under the deferred shipment notice provisions of the Purchase Agreement. Pursuant to such provisions, Osram elected during the December 2001 quarter to defer 43% of the original contracted amount to a later quarter than originally scheduled. In any event, the Purchase Agreement requires Osram to purchase all products by March 24, 2003. The -11- Purchase Agreement also provides for liquidated damages if the Company is unable to ship at least 85% of the cumulative quantity due to have been shipped each month. These damages are calculated at one percent per week of the purchase price of the delayed product, subject to a maximum of ten percent of the purchase price. If product shipments are delayed six weeks or more due to circumstances within the Company's control, then in lieu of liquidated damages, Osram may claim damages actually resulting from the delay up to forty percent of the purchase price of delayed products. Additionally, the Purchase Agreement provides for higher per unit prices early in the contract with reductions in unit prices being available as the cumulative volume shipped increases. The higher prices were negotiated by the Company to offset higher per unit costs expected earlier in the contract. In December 2000, the Company's subsidiary, UltraRF, entered into a Supply Agreement with Spectrian. Under this agreement, Spectrian has committed to purchase semiconductor components having a minimum aggregate purchase price of approximately $58 million during the two years ended December 31, 2002. In addition, UltraRF agreed to allocate sufficient capacity to supply Spectrian with quantities in excess of its minimum commitment by up to 20%. The minimum purchase amounts are fixed for each quarter during the two-year term of the agreement, with the aggregate of the eight quarters equaling $58.0 million. In October 2001, Spectrian and UltraRF agreed to modify the Supply Agreement under which the minimum purchase amount for the quarter ending December 23, 2001 was reduced and the subsequent two quarters increased so that the aggregate for the eight quarters remained at $58 million. In modification of the supply agreement, we also agreed that if we are not able to meet our proposed ramp up of LDMOS-8 production to Spectrian in the March 2002 quarter that Spectrian may be entitled to a credit of up to $2.1 million. Cree, UltraRF and Spectrian also entered into a development agreement, under which Spectrian provided R&D funding of $2.4 million. This work supports the development, by Cree and UltraRF, to improve high linearity and gain LDMOS power modules, and silicon carbide based RF power transistors for potential use in Spectrian's power amplifier products. Income Taxes The Company has established an estimated tax provision based upon an effective rate of 29% for the quarter ended December 23, 2001. The Company's effective tax rate was 34% for the quarter ended December 24, 2000. The estimated effective rate was based upon projections of income for the fiscal year and the Company's ability to utilize remaining net operating loss carryforwards and other tax credits. However, the actual effective rate may vary depending upon actual pre-tax book income for the year or other factors. Shareholders' Equity On January 18, 2001, the Company announced that its Board of Directors authorized the repurchase of up to four million shares of its outstanding common stock. Additionally, on March 22, 2001, the Company announced that its Board of Directors increased the repurchase limits under the stock repurchase program announced in January 2001 to include an additional three million shares, for a total of seven million shares of its outstanding common stock. For the three and six months periods ended December 23, 2001, the Company repurchased 42,000 shares and 705,000 shares, respectively, of its common stock at an average price of $15.04 per share for an aggregate of approximately $10.6 million. The repurchase program expired during January, 2002, however, management intends to seek board approval to renew the program. -12- Comprehensive (Loss) Income - --------------------------- Comprehensive (loss) income consists of the following: Three Months Ended Six Months Ended December 23, December 24, December 23, December 24, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ (In thousands) Net (loss) income $ (17,376) $ 13,861 $ (10,915) $ 26,515 Other comprehensive 2,130 (5,532) (4,628) (6,950) income (loss), net of tax ------------ ------------ ------------ ------------ Comprehensive (loss) $ (15,246) $ 8,329 $ (15,543) $ 19,565 income ============ ============ ============ ============ Earnings Per Share - ------------------ The Company presents earnings per share in accordance with Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). The following computation reconciles the differences between the basic and diluted presentations: Three Months Ended Six Months Ended December 23, December 24, December 23, December 24, 2001 2000 2001 2000 ------------ ------------ ------------ ------------ (In thousands, except per share amounts) Net (loss) income $ (17,376) $ 13,861 $ (10,915) $ 26,515 Weighted average common shares 72,457 71,495 72,705 71,154 ------------ ------------ ------------ ------------ Basic (loss) earnings per common share ($0.24) $0.19 ($ 0.15) $0.37 ============ ============ ============ ============ Net (loss) income ($17,376) $ 13,861 $ (10,915) $ 26,515 Diluted weighted average common shares: Common shares outstanding 72,457 71,495 72,705 71,154 Dilutive effect of stock options and warrants -- 3,705 -- 4,076 ------------ ------------ ------------ ------------ Total diluted weighted average common shares 72,457 75,200 72,705 75,230 ------------ ------------ ------------ ------------ Diluted (loss) earnings per common share ($0.24) $0.18 ($0.15) $0.35 ============ ============ ============ ============ Potential common shares that would have the effect of increasing diluted income per share are considered to be antidilutive. In accordance with SFAS 128, for the three and six months ended December 23, 2001, 8,892,675 and 8,843,688 shares, respectively, were not included in calculating diluted earnings per share and for the three months and six months ended December 24, 2000, 1,034,441 shares were not included in calculating diluted earnings per share because the effect would be antidilutive. -13- New Accounting Pronouncements - ----------------------------- On June 29, 2001, the Financial Accounting Standards Board ("FASB") unanimously approved the issuance of Statements of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", and No. 142, "Goodwill and Other Intangible Assets". SFAS 141 eliminates the pooling-of-interests method of accounting for business combinations except for qualifying business combinations that were initiated prior to July 1, 2001. SFAS 141 also includes new criteria to recognize intangible assets separately from goodwill. The requirements of SFAS 141 are effective for any business combination accounted for by the purchase method that is completed after June 30, 2001. Under SFAS 142, goodwill and intangible assets with indefinite lives are no longer amortized but are reviewed annually, or more frequently if impairment indicators arise, for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their useful lives. The amortization provisions of SFAS 142 requiring nonamortization of goodwill and indefinite lived intangible assets apply to goodwill and indefinite lived intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, we are required to adopt SFAS 142 in the fiscal year beginning July 1, 2002. Statements of Financial Accounting Standards No. 144 ("SFAS 144") provides guidance on differentiating between assets held and used and assets to be disposed of. The distinction is important because assets to be disposed of must be stated at the lower of the assets' carrying amount or fair value less cost to sell, and depreciation is no longer recognized. Assets to be disposed of would be classified as held for sale (and depreciation would cease) when management, having the authority to approve the action, commits to a plan to sell the asset(s) meeting all required criteria. If the plan of sale criteria are met after the balance sheet date but before issuance of the financial statements, the related asset would continue to be classified as held and used at the balance sheet date. Unless the undiscounted cash flow test indicated a loss was necessary on the balance sheet date, no loss would be recognized even if the asset is expected to be sold at a loss. -14- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Information set forth in this Form 10-Q, including Management's Discussion and Analysis of Financial Condition and Results of Operations, contains various "forward looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. These statements represent the Company's judgment concerning the future and are subject to risks and uncertainties that could cause our actual operating results and financial position to differ materially. Such forward-looking statements can be identified by the use of forward-looking terminology such as "may," "will," "anticipate," "believe," "plan," "estimate," "expect," and "intend" or the negative thereof or other variations thereof or comparable terminology. The Company cautions that such forward-looking statements are further qualified by important factors that could cause the Company's actual operating results to differ materially from those forward-looking statements. These factors include, but are not limited to, uncertainty regarding economic conditions; risks from increased competition; uncertain product demand; uncertainty whether we can achieve our targets for increased yields and cost reductions needed to maintain our margins; risks associated with the production ramp-up for new products; including the possibility of unexpected delays, increased costs and manufacturing difficulties or less than expected market acceptance; risks associated with the planned release of new products under development, including the possibility we will be unable to develop and manufacture commercially viable versions of such products; the risk of variability in our manufacturing processes that can adversely affect yields and product performance; the risk that our investments in third parties will generate losses; the risk that changes in customer concentration will adversely affect our sales; the possibility of adverse results in our pending intellectual property litigation; uncertainty whether our intellectual property rights will provide meaningful protection and concentration of our business among few customers. See Exhibit 99.1 for further discussion of factors that could cause the Company's actual results to differ. Overview Cree, Inc. is the world leader in developing and manufacturing semiconductor materials and electronic devices made from silicon carbide ("SiC") and gallium nitride ("GaN"). We recognize product revenue at the time of shipment when legal title transfers to our customers or in accordance with the terms of the relevant contract. Our financial statements also include estimates by management for reserves for inventory, accounts receivable and investments in privately held companies. We derive the largest portion of our revenue from the sale of blue and green light emitting diode ("LED") products. We offer LEDs at four brightness levels- X-Bright(TM) blue and ultraviolet products, MegaBright(TM) blue, green and ultraviolet products, high brightness blue and green products (now including our UltraBright(TM) blue and green devices) and standard brightness blue products. Our LED devices are utilized by end users for automotive dashboard lighting, LCD backlighting, including wireless handsets and other consumer products, indicator lamps, miniature white lights, indoor sign and arena displays, outdoor full color displays, traffic signals and other lighting applications. We introduced our new next generation LED X-Bright(TM) technology in the second quarter of 2002. The X-Bright(TM) family of LEDs is being designed to offer increased brightness by up to 50 percent over the MegaBright(TM) family of -15- LED's. Target applications for the X-Bright(TM) devices include solid state illumination, cell phones, automotive and video screens. We shipped sample quantities of our X-Bright(TM) chips during December 2001. These products have gained strong initial interest from our customers, but will require a design-in cycle that is expected to continue for several months. We also recently introduced the 505 traffic signal green and 525 signage green devices in the MegaBright(TM) product line. These diodes exhibit typical brightness increase of greater than two times the current UltraBright(TM) device brightness levels. The target applications for the MegaBright(TM) green devices are traffic signals, display signs and consumer products. During the first six months of fiscal 2002, the MegaBright(TM) blue and green products made up 26% of our LED revenue. We continue to develop the X-Bright(TM) green family of products. Revenue at the UltraRF segment was $17.5 million during the first six months of fiscal 2002. In the long term, UltraRF's success will depend on the rate at which we diversify our Spectrian-concentrated business. Currently over 90% of the sales of the UltraRF division are made to Spectrian under a supply contract which was entered into when we acquired UltraRF from Spectrian in December, 2000 and was subsequently modified. This supply agreement expires on December 31, 2002.We believe that the introduction of our new power amplifier module and LDMOS-8 RF power transistor devices along with our continued commitment to LDMOS research and development, will generate product design wins from new customers, consistent with our customer diversification strategy. We also believe that Spectrian will continue to be a customer after the expiration of the supply contract. However, the level and pricing of sales to Spectrian will be subject to market conditions once the supply contract expires. We derive additional revenue from the sale of advanced materials made from SiC that are used for manufacturing LEDs and power devices by our customers or for research and development for new semiconductor applications. The balance of our revenue is derived from government research contract funding. Results of Operations - --------------------- Three Months Ended December 23, 2001 and December 24, 2000 Revenue. Revenue decreased 1% to $41.1 million in the second quarter of fiscal 2002 from $41.5 million in the second quarter of fiscal 2001. This decrease was attributable to lower product revenue of $36.9 million in the second quarter of fiscal 2002 from $37.6 million in the second quarter of fiscal 2001. Without the acquisition of UltraRF, revenue for the second quarter would have been $33.3 million or 11% lower than the prior year comparative results. For the second quarter of fiscal 2002, LED revenue declined 19% from the prior year despite a 10% LED chip volume increase over units delivered in the second quarter of last year. Average LED sales prices declined 26% in the second quarter of fiscal 2002 compared to the second quarter of fiscal 2001 due to expected contractual volume discounts given to customers. Our MegaBright(TM) LED products, which first began shipping in July 2001, showed increasing customer acceptance as they grew to 37% of LED revenue during the second quarter. The MegaBright(TM) and X-Bright(TM) products will likely continue to replace some of the demand for older devices, as new customer product qualifications are completed. In December 2001, we sampled our first X-Bright(TM) products. These products have gained strong customer interest but will require a design cycle before significant sales -16- begin. Therefore, we target the sales of these products to begin in our fourth quarter of fiscal 2002. As a result of the growth of our MegaBright(TM) and X-Bright(TM) products, our high brightness chips (including UltraBright(TM) chips) declined from 79% of LED sales in the second quarter of fiscal 2001 to 38% of LED sales for the second quarter of fiscal 2002. Sales of our standard brightness chips made up 25% of LED revenue in the second quarter of fiscal 2002 compared to 21% of LED sales for the second quarter of fiscal 2001. Revenue from UltraRF was $7.8 million during the quarter with LDMOS products making up over 68% of revenue due to demand from Spectrian Corporation. As we completed the acquisition of UltraRF in December 2000, there were no sales from this unit in the comparable December 2000 quarter. UltraRF continues to ramp its production of LDMOS products currently being shipped for next generation wireless base station applications. We continue to work on new customer design wins, which will utilize this new technology. A successful ramp up of LDMOS-8 products is critical to meeting our contractual obligations with Spectrian. Material sales declined 35% in the second quarter of fiscal 2002 compared to the same period of fiscal 2001 due to significantly lower gemstone material sales. Sales of gemstone material products declined 84%, as there were only nominal sales to Charles & Colvard, or C&C during the second quarter of fiscal 2002. We anticipate little to no revenue from this customer over the next several quarters. SiC wafer sales revenue decreased 9% in the second quarter of fiscal 2002 compared to the same period of the prior year. Wafer units shipped increased 3%, while average sales prices declined 12% in the second quarter of fiscal 2002 compared to the second quarter of fiscal 2001. Contract revenue received from U.S. Government agencies and non-governmental customers increased 8% during the second quarter of fiscal 2002 compared to the second quarter of fiscal 2001 due to larger microwave contract awards received. We are currently seeing a trend in our sales activities where orders from our larger customers are slowing while orders from smaller customers are increasing. This change in customer mix improves the balance of our revenue stream as we decrease our customer concentration. However, this change also limits order visibility as smaller customers generally do not order as far in advance as larger customers. If the volume of orders from these smaller customers does not reach the level we currently anticipate, revenue for the second half of 2002 could be significantly less than expected. Gross Profit. Gross profit decreased 12% to $19.4 million in the second quarter of fiscal 2002 compared to $22.1 million in the second quarter of fiscal 2001. Compared to the prior year period, gross margin for the fiscal 2002 quarter decreased to 47% from 53% of revenue. Gross margin for the second quarter of fiscal 2002 at UltraRF was 44% of revenue. Profitability at UltraRF was lower than the prior sequential quarter due to a shift in product mix favoring a higher percentage of LDMOS products in comparison to bipolar products. LDMOS products had a lower average selling price and lower gross margins relative to the bipolar products. The LED product line realized lower profitability during the second quarter of fiscal 2002 in comparison to the prior year period due to overall contractual declines in average sales prices of 26% partially offset by a 20% decrease in manufacturing costs. We continue to focus on cost reduction as one of our highest priorities. We plan to manage our expense structure and reduce costs though process improvements and other efficiencies and to increase overall yields. -17- Research and Development. Research and development expenses increased 191%, or $4.4 million, in the second quarter of fiscal 2002 to $6.7 million from $2.3 million in the second quarter of fiscal 2001. Increased spending for research and development results from the combination of UltraRF expenses and increased internal funding to support microwave and optoelectronic programs. Without the addition of UltraRF expenses, research and development costs would have increased 143% from the second quarter of 2001. Internal funding for R&D will continue at these spending levels in the near term as we continue to focus on developing brighter LED's, improved LDMOS and SIC microwave and power devices and blue laser products. Sales, General and Administrative. Sales, general and administrative expenses increased 87%, or $2.6 million, in the second quarter of fiscal 2002 to $5.6 million from $3.0 million in the second quarter of fiscal 2001, due to the combination of UltraRF expenses and significant legal costs primarily associated with ongoing intellectual property litigation. Excluding UltraRF results, selling, general and administrative expenses would have been 54% higher than the prior year period as a result of greater costs incurred during the December 2002 quarter associated with patent litigation. Other Expense. Other expense was $18.8 million during the second quarter of fiscal 2002. This primarily consists of an impairment charge on property and equipment of $18.1 million taken during the quarter primarily due to technology decisions and changes. In accordance with SFAS 121, management reviews long-lived assets for impairment based on changes in circumstances that indicate their carrying amounts may not be recoverable. This impairment charge reflects management's decision on technology resulting from the progress made by our research and development teams. After extensively testing certain reactor technology equipment, we narrowed a preference for certain processes, and we intend to use these processes going forward. We wrote off non-producing reactor equipment which does not use the preferred processes. Also, in December 2001 management committed to a plan to begin a 3" wafer transition over the next 18-24 months. As a result, we wrote off non-convertible 2" crystal growth equipment that was not currently or expected to be in use. Finally, yield improvements also resulted in the obsolescence of certain other equipment. All equipment written off is being dismantled and destroyed if proprietary in nature, or sold where possible. These assets are being carried at the lower of their carrying amount or fair value less cost to sell. The remaining amount of $700,000 of other expense represents a one-time bonus paid to UltraRF employees. Other Non Operating (loss). The other non operating (loss) of $11.8 million primarily represents an "other-than-temporary" decline in value related to our long-term investments in privately-held companies in the amount of $12.4 million. Management conducts a quarterly impairment review of each investment in the portfolio, including historical and projected financial performance, expected cash needs and recent funding events. Other-than-temporary impairments for investments are recognized if the market value of the investment is below its cost basis for an extended period or the issuer has experienced significant financial declines or difficulties in raising capital to continue operations. This impairment charge was partially offset by a gain on the sale of marketable securities of $600,000. -18- Goodwill and Intangible Asset Amortization. As a result of the acquisition of UltraRF, we recorded goodwill and other intangible assets on its balance sheet which are being amortized over periods ranging from 5 to 10 years. No expense was incurred during the second quarter of fiscal 2001 due to the timing of the UltraRF acquisition. Interest Income, Net. Interest income, net declined $3.0 million or 69%, in the second quarter of fiscal 2002 in comparison to the second quarter of fiscal 2001. The reduction from the comparative quarter results primarily from lower interest rates available for our liquid cash as a result of aggressive interest rate cuts by the Federal Reserve. Income Tax (Benefit) Expense. Income tax benefit for the second quarter of fiscal 2002 was $7.1 million compared to an income tax expense of $7.2 million in the second quarter of fiscal 2001. The income tax benefit resulted from the $24 million net loss resulting from the charge taken for the impairment of fixed assets of $18.1 million and the $12.4 million charge for the reserve for investments in privately held companies. The effective income tax rate was 29% for the second quarter of fiscal 2002 compared to a 34% rate during the comparative period in fiscal 2001. This change in our effective tax rate is a direct result of the implementation of certain tax planning strategies. Six Months Ended December 23, 2001 and December 24, 2000 Revenue. Revenue increased 6.6% to $84.3 million in the first six months of fiscal 2002 from $79.1 million in the first six months of fiscal 2001. This increase was attributable to higher product revenue of $75.5 million in the first six months of fiscal 2002 from $71.9 million in the first six months of fiscal 2001. Without the acquisition of UltraRF, product revenue for the first six months of fiscal 2002 would have been $66.8 million or 17% lower than the prior year comparative period results. For the first six months of fiscal 2002, LED revenue declined 16% from the prior year period despite a 16% LED chip volume increase over units delivered in the first six months of last fiscal year. Average LED sales prices declined 28% in the first six months of fiscal 2002 compared to the first six months of fiscal 2001 due to expected contractual volume discounts given to customers. Our new MegaBright(TM) LED products showed increasing customer acceptance as they grew to 26% of LED revenue during the first six months of fiscal 2002. As a result of the growth of these products, our high brightness chips (including UltraBright(TM) chips) declined from 80% of LED sales in the first six months of fiscal 2001 to 47% of LED sales for the first six months of fiscal 2002. Sales of our standard brightness chips remained strong at 27% of total LED revenue in the first six months of fiscal 2002, compared 20% during the first six months of fiscal 2001. Revenue from UltraRF was $17.5 million during the first six months of fiscal 2002 with an even split of bipolar and LDMOS products being shipped. Most of the revenue demand was generated from Spectrian Corporation. As we completed the acquisition of UltraRF in December 2000, there were no sales from this unit in the first six months of fiscal 2001. Material sales declined 30% in the first six months of fiscal 2002 compared to the same period of fiscal 2001 due to significantly lower gemstone sales. Sales of gemstone products declined 85%, as there were only nominal sales to C&C during the first six months of fiscal 2002. We anticipate little to no revenue from this customer over the next several quarters. SiC wafer sales increased 6.5% in the first six months of fiscal 2002 compared to the prior year period. -19- This is due to demand for wafers used in LED and power products by our customers and increased interest by the research community. Wafer units increased 23%, while average sales prices declined 14% in the first six months of fiscal 2002 compared to the first six months of fiscal 2001. Contract revenue received from U.S. Government agencies and non-governmental customers increased 22% during the first six months of fiscal 2002 compared to the first six months of fiscal 2001 due to larger microwave contract awards received. Gross Profit. Gross profit decreased 8% to $39.3 million in the first six months of fiscal 2002 compared to $42.6 million in the first six months of fiscal 2001. Compared to the first six months of the prior year, gross margin for the first six months of fiscal 2002 decreased to 47% from 54% of revenue. Gross margin for the first six months of fiscal 2002 at UltraRF was 46% of revenue. The LED product line realized lower gross margins during that period in comparison to the prior year period due to contractual declines in average sales prices amounting to 28% being offset by manufacturing costs that were 15% lower. We continue to focus on cost reduction as one of our highest priorities. We plan to manage our expense structure and reduce costs though process improvements and other efficiencies and to increase overall yields. Gross margins also declined on materials revenue as wafer costs for SiC material sales were also higher comparing the first half of fiscal 2002 results to the first half of fiscal 2001 due to a change in product mix. Research and Development. Research and development expenses increased 148% or $6.5 million in the first six months of fiscal 2002 to $10.9 million from $4.4 million in the first six months of fiscal 2001. Increased spending for research and development results from the combination of UltraRF expenses and increased internal funding to support microwave and optoelectronic programs. Without the addition of UltraRF expenses, research and development costs would have increased 100% from the first six months of 2001. Sales, General and Administrative. Sales, general and administrative expenses increased 61%, or $4.3 million, in the first six months of fiscal 2002 to $11.3 million from $7.0 million in the first six months of fiscal 2001. The increase is due to the combination of UltraRF expenses and significant legal costs of $3.1 million in the first six months of fiscal 2002 primarily associated with ongoing intellectual property litigation. For further discussion on the intellectual property litigation see below in Part II, Item 1, Legal Proceedings. Excluding UltraRF results, selling, general and administrative expenses would have been 34% higher. Other Expense. Other expense was $19.7 million during the first six months of fiscal 2002. This is made up of a charge for the impairment of fixed assets during the six-month period due to technology changes and a one-time bonus of $700,000 for UltraRF employees. Other Non Operating (loss). The other non operating (loss) of $11.8 million in the first six months of fiscal 2002 was attributed to an "other than temporary" decline in value related to our long-term investments in the amount of $12.4 million recorded during the second quarter as discussed above. This charge was partially offset by a gain on the sale of marketable securities of $600,000. -20- Goodwill and Intangible Asset Amortization. As a result of the acquisition of UltraRF, we recorded goodwill and other intangible assets on its balance sheet, which are being amortized over periods ranging from 5 to 10 years. No expense was incurred during the first six months of fiscal 2001 due to the timing of the UltraRF acquisition. Interest Income, Net. Interest income, net declined $5.6 million, or 62%, in the first six months of fiscal 2002 compared to the first six months of fiscal 2001. The reduction from the comparative quarter results primarily from lower interest rates available for our liquid cash as a result of aggressive federal interest rate cuts by the Federal Reserve. Income Tax (Benefit) Expense. Income tax benefit for the first six months of fiscal 2002 was $4.5 million compared to an income tax expense of $13.7 million in the first six months of fiscal 2001. The income tax benefit resulted from the $15.4 million net pre-tax loss which was due to the charges for the impairment of fixed assets of $18.1 million and the $12.4 million reserve for investments in privately held companies. The effective income tax rate was 29% for the second quarter of fiscal 2002 compared to 34% during the comparative period of fiscal 2001. This change in our effective tax rate is a direct result of the implementation of certain tax planning strategies. Liquidity and Capital Resources - ------------------------------- We have funded our operations to date through sales of equity, bank borrowings and revenue from product and contract sales. As of December 23, 2001, we had working capital of $221.9 million, including $168.3 million in cash, short-term investments and marketable securities. Operating activities generated net cash of $23.8 million for the first six months of fiscal 2002 compared with $36.5 million generated during the comparative period in fiscal 2001. This reduction in cash provided by operations was primarily attributable to lower income from operations and timing differences attributable to our increase in deferred income tax assets and a decline in accounts payable. Capital expenditures of property, plant and equipment amounted to $21.8 million during the first half of fiscal 2002. In addition, $15.3 million was invested in available for sale securities and $40.0 million was invested in securities held to maturity during the second quarter of fiscal 2002. Proceeds of $47.0 million from securities held to maturity was used to reinvest in available for sale securities and in securities held to maturity. In addition, $7.9 million was invested in privately held companies. Cash used in financing activities during the first half of fiscal 2002 includes a total of 705,000 shares of common stock which have been repurchased on the open market for an aggregate of $10.6 million. In addition, we received $3.0 in proceeds from the exercise of stock options from our employee stock option plan. We currently have adequate cash and working capital resources on hand to fund near term capital expenditures and other planned items. We may issue additional shares of common stock for the acquisition of complementary businesses or other significant assets or enter into other capital transactions as needs and opportunities warrant. From time to time we evaluate potential acquisitions of and investments in complementary businesses and anticipate continuing to make such evaluations. -21- Item 3. Quantitative and Qualitative Disclosures About Market Risk Quantitative Disclosures - ------------------------ As of December 23, 2001, the Company maintains investments in publicly traded equity securities that are treated for accounting purposes under SFAS 115 as "available for sale" securities. These investments are carried at fair market value based on quoted market prices of the investments as of December 21, 2001, with net unrealized gains or losses excluded from earnings and reported as a separate component of stockholder's equity. These investments are subject to market risk of equity price changes. Management views these stock holdings as strategic investments; therefore, the shares are accounted for as "available for sale" securities under SFAS 115. The fair market value of these investments as of December 23, 2001, using the closing sale price of December 21, 2001 was $13.9 million. Qualitative Disclosures - ----------------------- Investments in the common stock of other public companies are subject to the market risk of equity price changes. While the Company cannot predict or manage the future market price for such stock, management continues to evaluate its investment position on an ongoing basis. PART II - OTHER INFORMATION Item 1. Legal Proceedings As discussed in the Company's Annual Report on Form 10-K for the fiscal year ended June 24, 2001, and the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 24, 2001, the Company intervened as a party in lawsuits filed by Nichia Corporation in December 1999 and April 2000 in the Tokyo District Court in which Nichia alleges that LED products manufactured by the Company infringe two Nichia patents, Japanese Patent Nos. 2,778,405 (the "405 patent") and 2,918,139 (the "139 patent"). Nichia originally filed two lawsuits based on the `405 patent but voluntarily dismissed one of the suits in October 2001. The Tokyo District Court dismissed the second lawsuit on the `405 patent in a decision issued in December 2001 in which the court found that the Company's high brightness LED products at issue in the case were non-infringing. Nichia has appealed this dismissal to the Tokyo High Court. The Tokyo District Court had previously dismissed Nichia's suit on the `139 patent in a decision issued in May 2001 in which the court found that the Company's standard brightness LED products do not infringe the `139 patent; Nichia's appeal from this dismissal remains pending before the Tokyo High Court. In July 2001, Rohm Co., Ltd. ("Rohm") filed a complaint against Nichia in the Tokyo District Court in which Rohm seeks a ruling that its sale of products that incorporate the Company's standard brightness LED products do not infringe the `139 patent. The Company intervened in this suit in December 2001 to assist in showing that its standard brightness LED products do not infringe the `139 patent, and the case remains pending before the district court. -22- As also discussed in the Company's Form 10-K and Form 10-Q reports noted above, the Company's subsidiary, Cree Lighting Company, is a co-plaintiff in a patent infringement lawsuit brought against Nichia and Nichia America Corporation and originally filed in the U.S. District Court for the Northern District of California in May 2001. The California district court in September 2001 provisionally granted the defendants' motion to transfer the case to the U.S. District Court for the Eastern District of North Carolina, subject to a determination by the North Carolina court of whether the case should be transferred. In November 2001 the North Carolina district court ruled that transfer was appropriate and has retained the case. Also pending before the North Carolina court is the previously-reported action brought by the Company and North Carolina State University against Nichia and Nichia America Corporation in which Nichia has counterclaimed against the Company, its subsidiary Cree Lighting Company and a former Nichia researcher now employed part-time by Cree Lighting Company. In October 2001, in response to Nichia's amended answer and counterclaim filed in September 2001, the Company and the Cree Lighting employee replied to the amended counterclaim, denying liability and asserting, in the Company's reply, claims seeking a declaratory judgment that the Nichia patents at issue are invalid, unenforceable and not infringed. The Company's reply also asserted a claim for damages in which the Company alleges that Nichia's actions in bringing the patent infringement counterclaims were not made for any legitimate purpose and constitute unfair competition under North Carolina law. In addition, the Company and the Cree Lighting employee named as a counterclaim co-defendant moved to strike or dismiss the allegations of the amended counterclaim in which Nichia asserted claims for trade secret misappropriation not based on any alleged actual misappropriation and claims under the Computer Fraud and Abuse Act. Cree Lighting Company also moved, in October 2001, to dismiss Nichia's claims against it for lack of proper venue. These motions remain pending. In November 2001, the Company was served with pleadings in which the Company is named as a defendant to a counterclaim of Nichia Corporation and Nichia America Corporation in a lawsuit pending in the U.S. District Court for the Eastern District of Pennsylvania. The complaint in the underlying action, which was brought by Rohm Co., Ltd. against Nichia Corporation and Nichia America Corporation, alleges that Nichia is infringing certain U.S. patents owned by Rohm. Nichia's counterclaim, as amended in December 2001, names both Rohm and the Company as counterclaim defendants and alleges that the Company and Rohm violated antitrust laws by conspiring to exclude Nichia from the U.S. market for high brightness light-emitting diodes. The counterclaim seeks actual and treble damages, attorneys' fees and court costs. The Company has moved to dismiss the counterclaim for lack of personal jurisdiction. Rohm has separately moved to dismiss certain counts of the counterclaims, including those asserted against the Company, for failure to state a claim on which relief can be granted. Both motions remain pending. Item 4. Submission of Matters to a Vote of Security Holders The Company's Annual Meeting of Shareholders was held on October 23, 2001. Directors were elected as follows: Name Votes For Votes Withheld ---- --------- -------------- F. Neal Hunter 66,904,810 156,408 Charles M. Swoboda 66,904,810 156,408 John W. Palmour, Ph.D. 66,904,810 156,408 Dolph W. von Arx 66,556,814 504,404 James E. Dykes 66,904,810 156,408 William J. O'Meara 66,904,810 156,408 Robert J. Potter, Ph.D. 66,854,710 206,508 -23- Item 6. Exhibits and Reports on Form 8-K (a) Exhibits The following exhibits are being filed herewith and are numbered in accordance with Item 601 of Regulation S-K: 10.19 Fiscal 2002 Management Incentive Plan * 99.1 Certain Business Risks and Uncertainties (b) Reports on Form 8-K: None. *Compensatory plan. -24- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CREE, INC. Date: February 5, 2002 /s/ Cynthia B. Merrell ----------------------------------------- Cynthia B. Merrell Chief Financial Officer and Treasurer (Authorized Officer and Chief Financial and Accounting Officer) -25- EX-10.19 2 f10q_q2x10.txt FISCAL 2002 MANAGEMENT INCENTIVE PLAN EXHIBIT 10.19 CREE, INC. MANAGEMENT INCENTIVE PLAN Fiscal Year 2002 Plan The following is a summary of the management incentive plan (the "Plan") adopted by Cree, Inc. (the "Company") for its fiscal year ending June 30, 2002. 1. Purpose: The purpose of the Plan is to motivate and reward excellent performance, to attract and retain outstanding senior management personnel, to create a strong link between strategic and corporate operating plans and individual performance, to achieve greater corporate performance by focusing on results, not activities, and to encourage teamwork at the highest level within the organization. The Plan rewards participants with a cash bonus payment based on their contribution towards the attainment of corporate and individual performance goals. The bonus payment is calculated as a percentage of base salary and the target award percentage varies according the position level. 2. Eligibility: Eligible participants include the Executive Chairman, the Chief Executive Officer and President, and senior level managers of the Company (or a consolidated subsidiary) who report directly to the Chief Executive Officer and President. 3. Plan Awards: 3.1 Target Award Levels: The target award level represents the award for 100% achievement of objectives. The target awards are expressed as a percentage of salary and vary based on the position of the participant. The actual target award amount is determined by multiplying the participant's base salary by the target award percentage. The target award is calculated on the base annual salary as of the payout date. Based on actual performance, a participant can earn between 0% to 100% of their target award. 3.2 Determination of Awards: For the positions of Executive Chairman and Chief Executive Officer and President, awards are based 100% on achieving predetermined corporate goals. Awards for all other eligible positions are determined based on performance against measures in two categories: Corporate and Individual. Corporate goals are weighted at 60% of the individuals total award payout. Individual goals are weighted at 40% of the individual's total award payout. 3.3 Corporate Measures: The Corporate performance measures and corresponding goals are based on meeting or exceeding revenue targets for the current fiscal year and meeting or exceeding net profit targets (excluding goodwill) for the current fiscal year. This is measured and paid annually to coincide with the fiscal year end. 3.4 Individual Measures: Individual performance measures are established at the beginning of each fiscal quarter. For each performance measure a performance goal (as a percentage) is determined. Performance goals are standards for evaluating success associated with a specific performance measure and are expressed as either Minimum or Target goals. Minimum performance goals are the lowest level of competent performance that is eligible for the award. Performance at the minimum performance level will yield an award which is 25% of the target award. Target performance goals are the expected level of performance. Performance at the target performance level will yield an award which is equal to the target award. Performance below the minimum performance level will not be eligible for an award. Each participant, in conjunction with the Chief Executive Officer and President, will develop a minimum of three (3) performance measures specific to their unit's performance. 4. Other Provisions: 4.1 Performance Threshold: In order to be eligible for an award performance thresholds as determined by the Chief Executive Officer and President must be met. Without limiting the foregoing, the corporate-level incentive component will not be paid if revenue and net profit targets for the fiscal year are not met. 4.2 Termination of Employment: If a participant's employment terminates prior to the end of an award period on account of death, disability under the Company's Long-Term Disability Plan, or retirement, the award will be calculated on a pro rata basis based on the number of months employed during the period. If a participant terminates during the award period for other reasons that those stated above, no award will be made. Any participant whose employment is terminated for cause after the end of the award period but prior to the payment of an award will forfeit any unpaid award. 4.3 New Hires: Participants who participate for part of the award period will receive a pro rata portion of the award based on the number of months of employment with the Company. 4.4 Exceptions: Calculated awards to participants can be increased or decreased at the discretion of the Chief Executive Office and President in a manner that will ensure that the Company's best interests are met. 4.5 Amendment: The Plan can be amended, modified, or terminated at any time, without prior notice to the participant, including any award (prior to payment) or any factors used to calculate awards. EX-99.1 3 f10q_q2x99.txt CERTAIN BUSINESS RISKS AND UNCERTAINTIES EXHIBIT 99.1 CERTAIN BUSINESS RISKS AND UNCERTAINTIES Described below are various risks and uncertainties that may affect our business. These risks and uncertainties are not the only ones we face. Additional risks and uncertainties not presently known to us, that we currently deem immaterial or that are similar to those faced by other companies in our industry or business in general may also affect our business. If any of the risks described below actually occurs, our business, financial condition or results of future operations could be materially and adversely affected. OUR OPERATING RESULTS AND MARGINS MAY FLUCTUATE SIGNIFICANTLY. Although we have had significant revenue and earnings growth in recent years, we may not be able to sustain such growth or maintain our margins, and we may experience significant fluctuations in our revenue, earnings and margins in the future. For example, historically, the prices of our LEDs have declined based on market trends. We have attempted to maintain our margins by constantly developing improved or new products, which command higher prices. If we are unable to do so, our margins will decline. Our operating results and margins may vary significantly in the future due to many factors, including the following: - our ability to develop, manufacture and deliver products in a timely and cost-effective manner; - variations in the amount of usable product produced during manufacturing (our "yield"); - our ability to improve yields and reduce costs in order to allow lower product pricing without margin reductions; - our ability to expand our production capacity for our new LED products; - our ability to produce higher brightness and more efficient LED products that satisfy customer design requirements; - demand for our products and our customers' products; - declining average sales prices for our products; - changes in the mix of products we sell; and - changes in manufacturing capacity and variations in the utilization of that capacity. These or other factors could adversely affect our future operating results and margins. If our future operating results or margins are below the expectations of stock market analysts or our investors, our stock price may decline. IF WE EXPERIENCE POOR PRODUCTION YIELDS, OUR MARGINS COULD DECLINE AND OUR OPERATING RESULTS MAY SUFFER. Our SiC material products and our LED and RF device products are manufactured using technologies that are highly complex. We manufacture our SiC wafer products from bulk SiC crystals, and we use these SiC wafers to manufacture our LED products and our SiC-based RF and power semiconductors. Our UltraRF subsidiary manufactures its RF semiconductors on silicon wafers purchased from others. During manufacturing, each wafer is processed to contain numerous "die," which are the individual semiconductor devices, and the RF power devices are further processed by incorporating them into a package for sale as a packaged component. The number of usable crystals, wafers, die and packaged components that result from our production processes can fluctuate as a result of many factors, including but not limited to the following: - impurities in the materials used; - contamination of the manufacturing environment; - equipment failure, power outages or variations in the manufacturing process; - losses from broken wafers or other human error; and - defects in packaging. We refer to the proportion of usable product produced at each manufacturing step relative to the gross number that could be constructed from the materials used as our manufacturing "yield." Since many of our manufacturing costs are fixed, if our yields decrease, our margins could decline and our operating results would be adversely affected. In the past, we have experienced difficulties in achieving acceptable yields on new products, which has adversely affected our operating results. We may experience similar problems in the future and we cannot predict when they may occur or their severity. In some instances, we may offer products for future delivery at prices based on planned yield improvements. Reduced yields or failure to achieve planned yield improvements could significantly affect our future margins and operating results. OUR BUSINESS AND OUR ABILITY TO PRODUCE OUR PRODUCTS MAY BE IMPAIRED BY CLAIMS WE INFRINGE INTELLECTUAL PROPERTY OF OTHERS. The semiconductor industry is characterized by vigorous protection and pursuit of intellectual property rights. These traits have resulted in significant and often protracted and expensive litigation. Litigation to determine the validity of patents or claims by third parties of infringement of patents or other intellectual property rights could result in significant expense and divert the efforts of our technical personnel and management, even if the litigation results in a determination favorable to us. Such litigation may be brought against us directly or against our customers with regard to their use, distribution or sale of our products. Whether or not we become a party to a suit brought against a customer, we could incur significant expense in indemnifying our customers, even if the litigation is resolved in our favor. In the event of an adverse result in any such litigation, we could be required to: -2- - pay substantial damages; - indemnify our customers; - stop the manufacture, use and sale of products found to be infringing; - discontinue the use of processes found to be infringing; - expend significant resources to develop non-infringing products and processes; and/or - obtain a license to use third party technology. Where we consider it necessary or desirable, we may seek licenses under patents or other intellectual property rights. However, we cannot be certain that licenses will be available or that we would find the terms of licenses offered acceptable or commercially reasonable. Failure to obtain a necessary license could cause us to incur substantial liabilities and costs and to suspend the manufacture of products. In addition, if adverse results in litigation made it necessary for us to seek a license or to develop non-infringing products or processes, there is no assurance we would be successful in developing such products or processes or in negotiating licenses upon reasonable terms or at all. Our results of operations, financial condition and business could be harmed if such problems were not resolved in a timely manner. Our distributor in Japan is presently a party to patent litigation in Japan brought by Nichia, in which the plaintiff claims that certain of our LED products infringe two Japanese patents it owns. The complaints in the proceedings seek injunctive relief that would prohibit our distributor from further sales of these products in Japan. The court has ruled in our favor on both suits; however Nichia has appealed the rulings. An adverse result in these cases would impair our ability to sell both our standard brightness and high brightness LED products in Japan and could cause customers not to purchase other LED products from us. Subject to contractual limitations, we have an obligation to indemnify our distributor for patent infringement claims. We have also initiated patent infringement litigation in the United States against Nichia and one of its subsidiaries, asserting patent infringement with respect to certain Nichia nitride semiconductor products, including laser diode products. Nichia has responded with counterclaims alleging, among other things, patent infringement claims against us based on four U.S. patents directed to nitride semiconductor technology. In addition, they allege trade secret misappropriation and related claims against Cree and a former Nichia researcher who is now employed by one of our subsidiaries on a part-time basis. An adverse result under Nichia's counterclaims would impair our ability to sell our LED products and could include a substantial damage award against us. Our Cree Lighting subsidiary has also initiated litigation in the United States against Nichia and one of its subsidiaries asserting patent infringement with respect to gallium nitride-based semiconductor technology useful in manufacturing certain LEDs and other devices. The lawsuit seeks damages and an injunction against infringement. -3- We have also been named as a counterclaim defendant in a suit brought by Nichia and its subsidiary in the United States District Court for the Eastern District of Pennsylvania citing alleged violations of antitrust laws. An adverse result under Nichia's counterclaims could include a substantial damage award against us, which would have a material adverse effect on our financial condition. We believe the claims asserted against our products in the Japanese cases and the counterclaims asserted against us by the defendants in the initial U.S. case are without merit, and we intend to vigorously defend against the charges. However, we cannot be certain that we will be successful, and litigation may require us to spend a substantial amount of time and money and could distract management from our day-to-day operations. Litigation costs to date in these cases have been substantial, and variability in these costs could adversely affect our financial results. If any of these cases were decided against us, the result would have a material adverse effect on our operations and financial condition. THERE ARE LIMITATIONS ON OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY. Our intellectual property position is based in part on patents owned by us and patents exclusively licensed to us by NCSU and others. The licensed patents include patents relating to the SiC crystal growth process that is central to our SiC materials and device business. We intend to continue to file patent applications in the future, where appropriate, and to pursue such applications with U.S. and foreign patent authorities, but we cannot be sure that patents will be issued on such applications or that our existing or future patents will not be successfully contested. Also, since issuance of a valid patent does not prevent other companies from using alternative, non-infringing technology, we cannot be sure that any of our patents (or patents issued to others and licensed to us) will provide significant commercial protection. In addition to patent protection, we also rely on trade secrets and other non-patented proprietary information relating to our product development and manufacturing activities. We try to protect this information with confidentiality agreements with our employees and other parties. We cannot be sure that these agreements will not be breached, that we would have adequate remedies for any breach or that our trade secrets and proprietary know-how will not otherwise become known or independently discovered by others. Where necessary, we may initiate litigation to enforce our patent or other intellectual property rights, but there is not assurance that we will be successful in any such litigation. Moreover, litigation may require us to spend a substantial amount of time and money and could distract management from our day-to-day operations. IF WE ARE UNABLE TO PRODUCE ADEQUATE QUANTITIES OF OUR MEGABRIGHT(TM) AND X-BRIGHT(TM) LED PRODUCTS AND IMPROVE OUR YIELDS, OUR OPERATING RESULTS MAY SUFFER. -4- We believe that higher volume production and lower production costs for our MegaBright(TM) and X-Bright(TM) LED products will be important to our future operating results. We must reduce costs of these products to avoid margin reductions from the lower selling prices we may offer to meet the competition and/or satisfy prior contractual commitments. Achieving greater volumes and lower costs requires improved production yields for these products. In addition, in the case of our X-Bright(TM) and MegaBright(TM) green LED products, we only recently began manufacturing these products in volume and may encounter delays and manufacturing difficulties as we ramp up our capacity to make these products. Our failure to produce adequate quantities and improve the yields of any of these products could have a material adverse effect on our business, results of operations and financial condition. OUR OPERATING RESULTS ARE SUBSTANTIALLY DEPENDENT ON THE DEVELOPMENT OF NEW PRODUCTS BASED ON OUR CORE SIC TECHNOLOGY. Our future success will depend on our ability to develop new SiC solutions for existing and new markets. We must introduce new products in a timely and cost-effective manner, and we must secure production orders from our customers. The development of new SiC products is a highly complex process, and we have historically experienced delays in completing the development and introduction of new products. Products currently under development include high power RF and microwave devices, power devices, blue laser diodes and higher brightness LED products. The successful development and introduction of these products depends on a number of factors, including the following: - achievement of technology breakthroughs required to make commercially viable devices; - the accuracy of our predictions of market requirements and evolving standards; - acceptance of our new product designs; - the availability of qualified development personnel; - our timely completion of product designs and development; - our ability to develop repeatable processes to manufacture new products in sufficient quantities for commercial sales; - our customers' ability to develop applications incorporating our products; and - acceptance of our customers' products by the market. If any of these or other factors become problematic, we may not be able to develop and introduce these new products in a timely or cost-efficient manner. WE FACE RISKS OF REDUCED REVENUE UNDER OUR CONTRACT WITH SPECTRIAN IF WE CANNOT RAMP UP PRODUCTION OF OUR LDMOS-8 PRODUCTS OR MEET CERTAIN PRODUCT SPECIFICATIONS. -5- Revenues of our UltraRF segment are dependent on our Supply Agreement with Spectrian Corporation, or Spectrian. If we are unable to ramp up production of our recently released LDMOS-8 products adequately over the next quarter, we may be required to credit Spectrian up to $2.1 million under the agreement. Consequently, our results of operations could be adversely affected both by delays in producing LDMOS-8 products and the amount of any applicable credit. In addition, if we are unable to supply other products that meet or exceed the specifications of certain competitive parts designated by Spectrian, Spectrian may purchase those products from other vendors, and the purchased quantities will be deducted from the minimum quantities required to be purchased from us under the Supply Agreement. The resulting reduction in revenue could have an adverse effect on our results of operations. WE DEPEND ON A FEW LARGE CUSTOMERS. Historically, a substantial portion of our revenue has come from large purchases by a small number of customers. For example, for fiscal 2001 our top five customers accounted for 72% of our total revenue. Accordingly, our future operating results depend on the success of our largest customers and on our success in selling large quantities of our products to them. The concentration of our revenues with a few large customers makes us particularly dependent on factors affecting those customers. For example, if demand for their products decreases, they may stop purchasing our products and our operating results will suffer. If we lose a large customer and fail to add new customers to replace lost revenue, our operating results may not recover. Recently, we have experienced a trend towards smaller customers gaining design wins from our larger customers for finished products incorporating our LEDs. While in the short term, this trend may lead to increased sales to smaller customers and an increase in the portion of our revenue that they represent, the long term effects of this trend are uncertain. In addition, smaller customers typically do not commit up front to purchase a specified volume over a long period of time, which reduces our ability to predict and maintain a steady stream of orders and revenue as sales to smaller customers increase as a percentage of revenue. THE MARKETS IN WHICH WE OPERATE ARE HIGHLY COMPETITIVE. The markets for our LED and RF and microwave power semiconductor products are highly competitive. Our competitors currently sell LEDs made from sapphire wafers that are brighter than the high brightness LEDs we currently produce and similar in brightness to our UltraBright(TM), MegaBright(TM) and X-Bright (TM) LED products. In addition, new firms have begun offering or announced plans to offer blue and green LEDs. In the RF power semiconductor field, the products manufactured by UltraRF compete with products offered by substantially larger competitors. The market for SiC wafers is also becoming competitive as other firms have in recent years begun offering SiC wafer products or announced plans to do so. We also expect significant competition for products we are currently developing, such as those for use in microwave communications and power switching. -6- We expect competition to increase. This could mean lower prices for our products, reduced demand for our products and a corresponding reduction in our ability to recover development, engineering and manufacturing costs. Any of these developments could have an adverse effect on our business, results of operations and financial condition. WE FACE SIGNIFICANT CHALLENGES MANAGING OUR GROWTH. We have experienced a period of significant growth that has strained our management and other resources. We have grown from 248 employees on June 28, 1998 to 970 employees on June 24, 2001 and from revenues of $44.0 million for the fiscal year ended June 28, 1998 to $177.2 million for the fiscal year ended June 24, 2001. To manage our growth effectively, we must continue to: - implement and improve operating systems; - maintain adequate manufacturing facilities and equipment to meet customer demand; - add experienced senior level managers; and - attract and retain qualified people with experience in engineering, design, technical marketing support. We will spend substantial amounts of money in supporting our growth and may have additional unexpected costs. Our systems, procedures or controls may not be adequate to support our operations, and we may not be able to expand quickly enough to exploit potential market opportunities. Our future operating results will also depend on expanding sales and marketing, research and development, and administrative support. If we cannot attract qualified people or manage growth effectively, our business operating results and financial condition could be adversely affected. PERFORMANCE OF OUR INVESTMENTS IN OTHER COMPANIES COULD NEGATIVELY AFFECT OUR FINANCIAL CONDITION. From time to time, we have made investments in public and private companies that engage in complementary businesses. Should these investments be deemed to be impaired, the related write-down in value could have a material adverse effect on our financial condition. Each of these investments is subject to the risks inherent in the related company's business and trends affecting the equity markets as a whole. Our private company investments are subject to additional risks relating to the limitations on transferability of our interests due to the lack of a public market and other transfer restrictions. Our public company investments are subject to market risks and also can be subject to contractual limitations on transferability. As a result, we may not be able to reduce the size of our positions or liquidate our investments when we deem appropriate to limit our downside risk. -7- OUR OPERATING RESULTS COULD BE ADVERSELY AFFECTED IF WE ENCOUNTER PROBLEMS TRANSITIONING PRODUCTION TO A LARGER WAFER SIZE. We are in the process of gradually shifting production of some products from two-inch wafers to three-inch wafers. We must first qualify our production processes on systems designed to accommodate the larger wafer size, and some of our existing production equipment must be refitted for the larger wafer size. Delays in this process could have an adverse effect on our business, particularly on our ability to sell some of our RF and power products at a competitive price. In addition, in the past we have experienced lower yields for a period of time following a transition to a larger wafer size until use of the larger wafer is fully integrated in production and we begin to achieve production efficiency. We anticipate that we will experience similar temporary yield reductions during the transition to the three-inch wafers, and we have factored this into our plan for production capacity. If this transition phase takes longer than we expect or if we are unable to attain expected yield improvements, our operating results may be adversely affected. WE RELY ON A FEW KEY SUPPLIERS. We depend on a limited number of suppliers for certain raw materials, components and equipment used in manufacturing our products, including key materials and equipment used in critical stages of our manufacturing processes. We generally purchase these limited source items with purchase orders, and we have no guaranteed supply arrangements with such suppliers. If we were to lose such key suppliers, our manufacturing efforts could be hampered significantly. Although we believe our relationship with our suppliers is good, we cannot assure you that we will continue to maintain good relationships with such suppliers or that such suppliers will continue to exist. IF GOVERNMENT AGENCIES OR OTHER CUSTOMERS DISCONTINUE THEIR FUNDING FOR OUR RESEARCH AND DEVELOPMENT OF SIC TECHNOLOGY, OUR BUSINESS MAY SUFFER. In the past, government agencies and other customers have funded a significant portion of our research and development activities. If this support is discontinued or reduced, our ability to develop or enhance products could be limited and our business, results of operations and financial condition could be adversely affected. IF OUR PRODUCTS FAIL TO PERFORM OR MEET CUSTOMER REQUIREMENTS, WE COULD INCUR SIGNIFICANT ADDITIONAL COSTS. The manufacture of our products involves highly complex processes. Our customers specify quality, performance and reliability standards that we must meet. If our products do not meet these standards, we may be required to replace or rework the products. In some cases our products may contain undetected defects that only become evident after shipment. We have experienced product quality, performance or reliability problems from time to time. Defects or failures may occur in the future. If failures or defects occur, we could: -8- - lose revenue; - incur increased costs, such as warranty expense and costs associated with customer support; - experience delays, cancellations or rescheduling of orders for our products; or - experience increased product returns. WE ARE SUBJECT TO RISKS FROM INTERNATIONAL SALES. Sales to customers located outside the U.S. accounted for about 69%, 69% and 59% of our revenue in fiscal 2001, 2000 and 1999, respectively. We expect that revenue from international sales will continue to be a significant part of our total revenue. International sales are subject to a variety of risks, including risks arising from currency fluctuations, trading restrictions, tariffs, trade barriers and taxes. Also, U.S. Government or military export restrictions could limit or prohibit sales to customers in certain countries because of their uses in military or surveillance applications. Because all of our foreign sales are denominated in U.S. dollars, our products become less price competitive in countries with currencies that are low or are declining in value against the U.S. dollar. Also, we cannot be sure that our international customers will continue to place orders denominated in U.S. dollars. If they do not, our reported revenue and earnings will be subject to foreign exchange fluctuations. IF WE FAIL TO INTEGRATE ACQUISITIONS SUCCESSFULLY, OUR BUSINESS WILL BE HARMED. We completed two strategic acquisitions during calendar year 2000. We will continue to evaluate strategic opportunities available to us, and we may pursue other product, technology or business acquisitions. Such acquisitions can present many types of risks, including the following: - we may fail to successfully integrate the operations and personnel of newly acquired companies with our existing business; - we may experience difficulties integrating our financial and operating systems; - our ongoing business may be disrupted or receive insufficient management attention; - we may not cost-effectively and rapidly incorporate acquired technology; - we may not be able to recognize cost savings or other financial benefits we anticipated; - acquired businesses may fail to meet our performance expectations; - we may lose key employees of acquired businesses; -9- - we may not be able to retain the existing customers of newly acquired operations; - our corporate culture may clash with that of the acquired businesses; and - we may incur undiscovered liabilities associated with acquired businesses that are not covered by indemnification we may obtain from the seller. We may not successfully address these risks or other problems that arise from our recent or future acquisitions. In addition, in connection with future acquisitions, we may issue equity securities that could dilute the percentage ownership of our existing shareholders, we may incur debt and we may be required to amortize expenses related to intangible assets that may negatively affect our results of operations. -10- -----END PRIVACY-ENHANCED MESSAGE-----